Investor dynamics in the BPO space

PV Kannan, Founder & CEO 24/7 Customer

At the outset I would like to highlight the fact that the business landscape in which BPO companies operates is very different from most other businesses and specifically IT offshore outsourcing. It is imperative to understand this difference in order to understand investor expectations and manage them better.

To start with the BPO business is quite distinct from the IT industry that it is often seen as an extension of. The most significant difference is that a BPO program entails taking over and running entire processes for the customer. In other words it is something like running a specific part of the business for that customer.

This requires significant investment of efforts, resources and processes that make it extremely challenging for BPO companies to scale rapidly in terms of number of customers, unlike in IT where 20 new customers can be acquired in a quarter. For a BPO company handling 20 customers is akin to setting up 20 new businesses - often from different business domains and with varied requirements that are specific to that business. And scaling from 20 programs to 100 programs becomes a daunting task for any BPO. To add yet another dimension to the challenge a BPO company takes well over 6 to 9 months to clinch a deal and close to a quarter to set up, effectively transition and achieve SLAs on a new program.

As a result BPO companies place greater emphasis on creating "customer for life" opportunities rather than amassing new customers. The thrust on scaling up existing programs, delivering enhanced value and obtaining repeat business from current customers is very high.

BPO investor goals

All of the above - the unique BPO business dynamics, the distinct challenges and longer cycle times make BPO a completely different investment proposition. As such the expectations from investors are also tuned to this. For instance where each deal takes 6 to 9 months to clinch, quarter on quarter results are perhaps not the best yardsticks for investors. To understand this better let us first take a look at the types of investors based on their end goals.

• The "100 meters" type- There are investors who are in for short terms gains with a window of around a year and looking at valuations in the region of 1.5 times. Typically such investors would look for merger options or sellout
• The "3000 meters" type-The medium term investor looks at better valuations (around 3 to 5 times) and has a longer window of 1 to 3 years. Such investors would look for strategic opportunities like M&A or sometimes an IPO to cash in
• "The Marathoners" - The long term investor is obviously looking at building for the long haul. The focus here is on value creation through professional management, unique positioning, differentiated service lines etc. Such investors act as the conscience of the company and clearly demonstrate the intent to create value over the long term. They typically invest early and expect a return of 10 times or more

While the short term and mid term investors have a common focus on valuation through opportunity attractiveness as the main focus (albeit at different levels), the long term investor focuses on valuation through value creation. This difference in goals determines the key factors that drive investor needs and expectations.

The short/mid term focused investors, look at a BPO company from the point of view of value appreciation. Typical triggers would be:

- Capability to scale
- Revenue and profitability
- Attractiveness of current customer base
- Delivery stability

The long term investor looks for all of the above but is also discerning on a number of other parameters that influence an organizations' ability to create value. Questions that such an investor would seek answers to include:

- Does the BPO organization have a differentiated business model
- Does the company place emphasis on building value added service offerings
- Are sustainability and predictability core to the capability of the company
- Does the company demonstrate the ability to create market leadership
- Is the company able to attract and globally serve its customer base
- Is the company able to sustain market pressures
- Does the company adopt a long term view of initiatives like process consulting, knowledge management, branding etc

The long term investors not only look at the return but the success of the business that has been created through their investments. This for them helps attract future investment opportunities

The current BPO market: Investor view

The BPO industry today is managed in a variety of types with investors playing different roles. Here are some:

- Entrepreneurs, who are majority stakeholders, with minority investments from VCs and run the company professionally and take the long-term view of building a company that lasts
- Companies that are backed by majority private equity or venture capital funding
- Professionally run companies and part of publicly listed companies
- Fully owned by the seed investors

As in any new industry the seed round investors carry more risk and higher reward as there is no visibility on the maturity of the industry. As the industry gets more defined the risk and reward balance tilts, with first round and second round funding having the risks and rewards more well defined with a clear time frame. The BPO industry five years back had seed investors/ angel investors investing in companies with a business model that was not proven. Today the rewards they would reap from the companies they invested in are very high.

Investors interested in first round or second funding in today's BPO companies face the question of whether the valuation is at the "right price" and whether it is close to their "sweet spot". This is obviously due to the rapid growth, maturity of the industry. If the company they are investing is in a matured service line such as offshore contact centres, the current industry capability would serve as a good benchmark to find if there is any uniqueness in the service or model being offered. If not the valuation for investment is bound to get corrected and hit reality for the company seeking investment. Investment in companies that offer services such as contact centres, data entry, finance and accounting etc are bound to undergo this "benchmarking test". In a way that helps the investor, puts pressure on the company seeking investment to differentiate itself. This segment might not attract the short-term investors any more and might be restricted only to medium and more the long-term investors.

For BPOs offering relatively newer service lines the options for investors remains large. We can expect to see more investors in companies with new service lines. Fortunately since the BPO industry has grown and matured the questions of industry stability and viability of offshore business model does not arise. Hence the uniqueness of the service line by itself would be a good evaluation point for investors.

Irrespective of the type of BPO or the type of investor, there are a few key factors that drive investor behaviour in BPO. The industry has been witness to consolidation of businesses through buyouts and mergers. In such instances investors are driven by customer demands and competition as well as pressure on short-term returns. Looking forward, the emergence of new service lines through new delivery models, new geographies or productisation spells an exciting opportunity that investors would clearly watch out for in the BPO space.

Source: NASSCOM's Handbook - ITES-BPO Industry - 2005 Background and Reference Resource